Cerulli: Courts Could Decide Fee Regulation

Whatever happened to 12b-1 fee regulation?

The regulatory debate is not playing out in the offices of the Securities and Exchange Commission (SEC) but in disparate courthouses across America, according to a new Cerulli report. “In the publicized lashing of the mutual fund industry and its fees in 2003, many expected the SEC to further clarify, if not overhaul, rules regarding revenue-sharing and remuneration,’ the report says. “But rather than clarification, uncertainty has lingered.’

In 2007, the SEC said it planned to address the issue of 12b-1 fees (see “Cox Says 12b-1 Fees a “Sales Load in Drag’). The agency solicited open comments. Since then, the issue has faded into the background. A Cerulli survey of asset managers in October 2008 found that 36% see fees and revenue-sharing concerns moving to the back burner as the SEC has “bigger fish to fry.’ Another 37% think concerns about fees and underperformance of active managers will lead to more interest in exchange-traded funds (ETFs), and 27% were unsure.

Cerulli said even mild reform scenarios of such fees could post industry problems. For instance, the SEC has hinted that one outcome is for 12b-1 fees to be divided and relabeled into two fees: one for fund distribution and the other for shareholder servicing.

Proposed regulation from the Department of Labor, which was never passed before the new Administration took over, did not address the issue head-on. Cerulli notes information about expense ratios, loads, and redemption fees (such as 12b-1 fees) was absent from the proposed regulations. Advisers and others expressed concern about the haziness around indirect compensation in the proposed fees (see “Advisers Still Headed for More Fee Transparency).

Instead of regulation, lawsuits might decide what the future holds for mutual fund fees, Cerulli says. A myriad of cases about 401(k) fees have surfaced in the last few years (see “Fee for All). Most recently, a lawsuit about unreasonable fees filed against Deere & Co. and two units of Fidelity Investments was dismissed (see “Appellate Court Backs Revenue-Sharing Case Dismissal and “IMHO: “Winning’ Ways).

Consultant View

According to a survey by Cerulli, the largest number of institutional investor consultants (57%) said once plan costs have been defrayed, all excess revenue-sharing should benefit participants in the form of vital services or reduced fees (37% were neutral). Forty-five percent said revenue-sharing can be beneficial for all parties when fully disclosed. Almost half (49%) said hard-dollar pricing is the wave of the future. However, 38% (55% neutral) said recordkeepers and custodians would have to exit the business if revenue-sharing were eliminated.

Advisers using revenue-sharing might also face tighter regulation. It is unclear if Congress or regulation will step up, but getting paid out of mutual fund revenues could be at risk, said Louis Harvey, president of DALBAR, Inc., to PLANADVISER last month. “If I were starting a retirement plan practice today, there’s no question I would make it fees and not the 12b-1 route,’ he said.